Ukraine Restructures and Fed Decision Looms

Welcome back to SovereignBeat!

In this publication:

• US Growth Doubles in Q2

• PCE Inflation Up Only 0.1%; Fed is set to meet on Tueday

• NASDAQ and S&P Fall for Two Weeks—Small Caps Take the Lead

• OPEC Scrambles as Future Production Plans Remain Unclear

• Breakdown of Ukraine’s Restructuring Deal—Last-Minute Agreement Just Before Deadline

Let’s dissect

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Markets Snapshot

Macro and Fixed Income Markets

• US: The Federal Reserve’s preferred measure of US inflation, core personal consumption expenditures (PCE) index, which excludes volatile food and energy items, increased 0.2% in June vs May and was up 2.6% on annual basis, according to the Bureau of Economic Analysis. On a three-month annualized basis, core inflation cooled to 2.3%, the lowest since December. The non-core PCE index increased just 0.1% on the month and was up 2.5% from a year ago.

• The data offers encouraging signs that the Fed’s monetary tightening campaign is bringing inflation toward its 2% target without breaking the economy. While the Federal Open Market Committee is expected to maintain their benchmark interest rate in the 5.25% - 5.50% range at the July 30-31 meeting, markets have fully priced in the first 25 bps rate cut in September, with an implied probability of over 99%.

• The cooling labor market is beginning to impact purchasing power. Wages and salaries increased by 0.3% in June, which is half the rate of the previous month. Though spending continued to grow at a healthy, albeit slower rate, income growth slowed more rapidly. Given that unemployement rate has edged higher in each of the last three months, it is likely that consumption will continue to decrease further in the second half of the year. The saving rate fell to 3.4%, the lowest since December 2022, suggesting consumers have less financial flexibility to increase spending in the coming months.

• The Bureau of Economic Analysis has also published data showing that the US economy grew at a 2.8% annualized rate in the second quarter. Thursday's data exceeded economists' expectations of 2% GDP growth between April and June represents a significant increase from the 1.4% growth rate in the first quarter.

• On the economic calendar this week, in addition to more quarterly earnings reports and the U.S. Federal Reserve's policy meeting on Tuesday and Wednesday, the U.S. Bureau of Labor Statistics will release its jobs report on Friday. This will show how July’s job growth stacks up against June’s stronger-than-expected gain of 206,000 jobs.

Equity Markets

• The S&P 500 and NASDAQ fell for the second week in a row, with the S&P dropping 1.5% and the NASDAQ down 3.2%. In contrast, the Dow gained for the fourth consecutive week, albeit modestly, rising just 0.43%. Despite light rallies on Monday and Friday, the S&P 500 and NASDAQ could not recover from a sell-off on Wednesday.

• The performance shift within the U.S. equity market continued into a third week, with large-cap stocks trailing the previously lagging small-cap segment and growth equities underperforming value stocks. Over the past three weeks, the large-cap benchmark (companies with market capitalisations of $10 billion or more) fell a cumulative 1.5%, while the small-cap index surged 11.5% (between $250 million and $2 billion).

Commodity Markets

• Oil: As global demand expectations weaken, Brent crude oil prices have fallen for two consecutive weeks, dropping 3.4% last week to around $79.85 per barrel—its lowest level in nearly two months. Oil was trading as high as $87 per barrel on July 4.

• Analysts are divided on whether OPEC+ will proceed with plans to boost supplies next quarter. OPEC+ has been limiting production for nearly two years to support prices and aims to restore 2.2 million barrels a day by late 2025. However, slowing economic growth in China and new oil supplies from the Americas keep prices lower and pose risks to this plan. OPEC+ has an online monitoring meeting scheduled for August 1, where officials may reconsider their strategy due to recent price drops. Advancing the supply increase could help exporters like Russia, Iraq, and Kazakhstan, who have been slow to comply with production cuts

In Motion

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Global Finance

Breakdown of Ukraine’s Restructuring Agreement

Last week, Ukraine secured a last-minute agreement in principle with the ad-hoc bondholders committee to restructure $20 billion of external debt, with the terms likely to be considered favorable enough to meet the IMF approval threshold. The committee and its investors represent approximately 25% of Ukraine’s outstanding Eurobonds.

• Based on the agreed terms, a conservative recovery estimate is around 35 cents on the dollar, factoring in a 120% claim (including PDI) plus a consent solicitation fee and assuming a 15% exit yield. It will reduce Ukraine’s debt stock by $8.67 billion, equivalent to $11.4 billion in debt servicing over the next three years and $22.75 billion until 2033. Bondholders will incur an upfront nominal haircut of 37% and a roughly 60% reduction in net present value terms, according to a statement from the Ukrainian Ministry of Finance. Ukrenergo’s bonds will not be included in the sovereign restructuring, but Ukravtodor’s will be.

• The restructuring will introduce two new bond series to replace existing claims:

  Standard Bond Series (Bond A): This series will account for 40% of the outstanding claims. It will begin paying interest from next year, with maturities ranging from 2029 to 2036 and will start amortizing in 2029.

  Contingent Bond Series (Bond B): Representing 23% of the outstanding claims, this series will mature between 2030 and 2036. It will not pay interest until 2027 but includes a contingent component. If Ukraine's economy exceeds IMF expectations in 2028, payments may increase, potentially reducing the nominal haircut to 25%.

• Fitch Ratings downgraded Ukraine’s Long-Term Foreign-Currency (LTFC) Issuer Default Rating (IDR) from CC to C. The agency classified the agreement as a "distressed debt exchange" and plans to downgrade the rating to 'RD' once the exchange is executed, indicating a restricted default.

• The government also committed to pay all deferred fees to GDP warrant holders, while removing the cross-default provisions tied to these warrants, which diminishes their bargaining power. Payments to warrant holders are tied to Ukraine's GDP performance, increasing when specific growth thresholds are met. These thresholds include real GDP growth above 3% and 4% annually. Ukraine exceeded both of those in 2019, 2021 and 2023. The warrants were introduced as a sweetener for creditors during Ukraine's 2015 debt restructuring, following Russia's annexation of Crimea.

• A coalition of hedge funds, including Aurelius Capital Management LP and VR Capital Group, is organising for debt-restructuring talks to address about $2.6 billion in warrants. Ukraine is set to pay a combined $250 million for a consent fee and 2021 deferred warrant payment on August 1. Nonetheless, these warrants, excluded from the agreement in principle with international bondholders, rose by about 9 cents to 58 cents on the dollar last week, the highest since early 2022, reflecting investor optimism over the government's commitment to debt payments. The government is likely to attempt converting warrants into newly issued bonds at some point, though the specific terms of such a deal remain uncertain.

• Ukraine will launch the restructuring via an exchange offer and consent solicitation, exchanging each Eurobond for a package of new A and B bonds. Ukravtodor’s outstanding Eurobonds will be exchanged on the same terms as the government’s sovereign debt. To pass the upcoming consent solicitation, the government needs approval from bondholders representing at least 75% of the total outstanding bonds across all series

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